Think of it like diversifying. If you were asking “Should I buy small cap or large cap?” We’d be virtually unanimous in saying “Both!”
Well, paying down a mortgage is something like an investment in itself, with a rate of return equal to the percentage interest rate. It’s a very low-risk investment and you’re likely to get a good return on it.
Equities have more risk, but they’re also more likely to produce a higher return over the long run.
So the simple investment advice is that you should diversify. Assuming you don’t already have significant investments in equities, you should put some money each month in stock and some to pay down the mortgage early. (Or alternate months or whatever works for you).
I paid mine off early too. The advice given to me by my father, a life long real estate agent, was: If you’re going to overpay on your mortgage, it’s something you have to commit to. Overpaying a month here and a month there, isn’t going to do jack squat.
Decide how much you can afford to overpay every month and keep doing that with out fail.
I paid my house off in 10 years. Would have been sooner but I didn’t do the math until 4 or 5 years into the mortgage. That was back when 8% was a good rate.
What needs to be considered is the cost of the loan and the rate of appreciation of houses. I based my decision on the high cost of interest and an expected collapse in the housing market. It worked out for me because the collapse in housing coincided with a massive financial slump. I lost my job and still had a house to live in. If I was young and starting from scratch today and bought a house at the bottom of the bubble and had an interest rate of 2% or 3% I would let it ride and spend the excess money flipping houses.
I would have to disagree with your father. Overpaying by a little does a little bit of good. Let’s say you throw in $50 extra just this once. Maybe it saves you $2 this year in interest and $2 the year after that and so on. Over 30 years, you’ve saved $60 in interest. A penny saved is still a penny saved. There’s no penny that doesn’t count.
Obviously, you see more benefit if you do this consistently. In that sense, it’s good advice to do it consistently, but I would never discourage someone from doing a little.
Remember that when interest rates increase the value of the bond you are holding decreases. So if you don’t hold the bond till maturity (if you sell it) it will almost CERTAINLY be less valuable because interest rates are so low now and they really only can go up.
Likewise, holding the bond would be silly also; when interest rates increase there is bound to be SOME increase in inflation. You have to net the interest return of the bonds versus the rate of inflation. If a bond gives you 3% and inflation is 2% you are effectively only earning 1%.
You may not have any capital gains tax, but you will have dividends…there will be one of the two. The result is a tax liability.
Maybe someone can explain this to me. I’m interested in this subject and just went and looked a calculator that tells you how much you will save by overpaying. I put in my loan info and plugged in a $200 over payment each month. I would pay off my loan 9 years and 11 months early (great!) Here’s where I’m a little confused. It says overall I would save $50,783 in interest (great!) But since I just got my mortgage last September, I still would have 20 years and 1 month of payments. $200 per month for 241 months is $48,200. So I’m paying $48,200 to save $50,783. While it’s something, that’s not a huge amount. Am I missing something?
The savings is interest saved (or perhaps better to phrase it as interest expense not incurred). Some of the money pays down the principal balance of the mortgage; that portion is not going to show up as savings.
If you thought of your mortgage as being one giant sum of principal + expected interest, then your total benefit from the early payments could be thought of as 98,983.
I overpaid mine and paid off a 30 year loan in 7 years.
Then, I needed a second house for two years. So we took out a loan for about 1/3 the value of this house to buy that house.
Then we sold that house, and paid off about half the mortgage. The rest I sunk into equities. My interest rate is really low (3.25%), I get a tax write off on the interest, and I think that I can get at least 8% long term on the equities. Last year being a good year on the stock market, we did pretty good on that delta, we will probably have years where the market goes down, too
Why? If you live in the US, there will be some capital gains and/or dividends to tax, even in a tax efficient fund. This should enter into your calculations.
I would pay down the mortgage for the tax-free 4.50 return on the money and the accumulation of savings on interest payment.
I think that’s just you. On both properties I’ve bought, my mortgage coupons actually have a line labeled “Additional Principle.”
Sounds like your mortgage company was trying to [del]force[/del] “encourage” you to sign up for the “Bi-weekly Payment Plan” (for a modest additional fee, of course).
Your question is to scattered to allow a direct, definitive answer.
It doesn’t matter where the rates go, your mortgage is 4.5%. You will ONLY, EVER get a 4.5% return (but that’s not factually true), and ONLY for 14 yrs.
Why would you buy a tax efficient investment if there’s no capital gains tax?!?
You’re trying to steer the answers with your conditions.
Very few finance books advise paying off the mortgage. There are only a few situations that merit it. Sure, it will feel good to be debt free, but feelings aren’t measurable return on investment. If your feelings dictate the answer, everyone else’s answers are moot, making your question rhetorical.
There are few finance books that would suggest you pay off your mortgage in comparison to a higher yielding risk free asset, such as a US bond. However, with today’s bond rates that is a joke.
If you haven’t refinanced to take advantage of historically low interest rates you should do that first. (30-year rates were 4% last week. 15-year rates were even lower.)
You should only pay off your mortgage if you cannot beat that rate with your investments. We’re currently paying 4% in mortgage interest, which is tax deductible, while earning an average of 12% per year on our investments. That’s a no-brainer.
Of course, this doesn’t take into account your personality. If it’d truly make you happy to be mortgage-free, then I agree with the others who advise taking a hybrid approach and investing half in investments and half in paying down your mortgage.
I also agree that it’d be wise to take out a HELOC now, even if you don’t need it because for a modest annual fee, you’ll have access to that equity should something catastrophic happen. Banks don’t lend money to people who really need it.
But remember to reduce the return on paying off your mortgage by the tax savings you get from mortgage interest.
The big difference is in liquidity. While more equity in a home makes it more possible to get a home equity loan, the conditions where you would want one (like being out of a job) make it less likely. Bonds can be sold without reference to your employment status. And in these terms the leverage you get from a mortgage means that housing price swings are more damaging than those of the equity market.
Say you have 10% equity, and your home goes down 5% in value. That’s a 50% hit. If the market goes down 5%, you hardly even notice it.
What effect liquidity has on desired return on investment is an individual thing.
That’s right, a house is a hugely illiquid asset and even if you sell it you still have to find someplace to live. I overpay my mortgage, but only after maxing out my 401k and my wife her IRA, and I treat it as if it were part of my bond allocation, so my other investments are overweighted towards equities. The overpayment on the mortgage is around 20% of my total annual money put into savings.
I see a house as an investment in the sense that you are forgoing payment of “rent”, a necessary expense, by having a house paid for. Forgoing an expense can be just as good as recognizing a revenue if it increases your net profit.
Dead on with the tax considerations - it just depends how much you value shielding income from the IRS. Individual situations will vary that answer greatly.
The bond, although a liquid asset, is extremely sensitive to interest rate risk, the more with time to maturity.
Right now if you had a 30 year bond at 3.4% and the rate goes up to 6.5% after 10 years (as it did in 2000), your market value of the bond is $773. If you sold it you would lose money. (Assuming no coupons for simplicity)
Decreasing an expense may be your better and more reliable option compared to recognizing interest.